The Myth of The Asian Market for Alberta’s Oil

For years, we’ve been told again and again (and again) that Kinder Morgan’s proposed expansion of the Trans Mountain pipeline is desperately needed for producers to export oil to Asian countries and get much higher returns.

The way it’s been framed makes it seem like it’s the only thing standing between Alberta and fields of gold.

Small problem: Canadian producers already have the ability to ship their heavy oil to Asia via the existing 300,000 barrel per day Trans Mountain pipeline — but they’re not using it.

In 2017, the Port of Vancouver only shipped 600 barrels of oil to China. That’s less than a tanker load. That same year, the port shipped almost 13 million barrels of oil, or about 24 Aframax tanker loads, to the U.S.

In other words: oil tankers are being loaded in Vancouver, but instead of heading to vaunted Asian markets, they’re heading south to California.

Shipments to Asia reached their peak seven years ago when the equivalent of nine fully loaded tankers of oil left Vancouver for China. Since then, oil exports to Asia have completely dropped off.

Some experts suggest exports to Asia are very unlikely to rebound in the short-term, with producers from many other countries continuing to dominate such markets. Others take a more long-term view, remaining optimistic that opportunities will arise over time — and only after the pipeline is actually built

“There’s no appetite in Asia for heavy oil,” said Eoin Finn, former partner at KPMG, in an interview with DeSmog Canada. “They don’t have the refineries to refine it. And the world is swimming in light sweet crude that’s cheaper and easier to refine, and altogether more plentiful.”

“There’s no appetite in Asia for heavy oil. They don’t have the refineries to refine it. And the world is swimming in light sweet crude that’s cheaper and easier to refine, and altogether more plentiful.” https://t.co/XCN92a02eS

No guaranteed access to Asian markets

One challenge is that the Port of Vancouver can’t even physically fit the size of tanker required to economically compete with other shippers of oil to Asia.

The largest class ship that is allowed in Burrard Inlet is what’s known as an “Aframax.” It can only be filled to 80 per cent capacity due to depth restrictions. That means a tanker from the Port of Vancouver can only ship 550,000 barrels at a time.

Meanwhile, Very Large Crude Carriers — yes, that’s actually their name — are now embarking from Louisiana via its brand new port, carrying two million barrels each. They’re also used by many Middle Eastern producers.

Practically, this means that Trans Mountain will have a harder time competing with producers in countries that can pay far less to ship their cheaper-to-refine oil in much larger ships. Trans Mountain supporters suggest this could become quickly irrelevant if situations change: say, a war breaks out in the Middle East and takes millions of barrels per day offline.

There’s also no guaranteed demand for Alberta’s lower quality crude on the other side of the Pacific. While 13 producers and shippers have signed long-term contracts with Trans Mountain — a fact that’s leaned on heavily by the company to make its business case, as they represent 80 per cent of expanded capacity — none have buyers in Asia yet.

“It’s a bit of a chicken and egg scenario. You need to build that pipeline before people are going to spend billions of dollars configuring their refineries to take your crude,” Jackie Forrest of ARC Energy Research told the CBC in a 2017 interview.

It’s expected that “sample shipments” of oil would be sent to various markets for testing once the pipeline was built.

But there’s very little proven interest in Alberta’s hard-to-refine oil. Instead, Asian countries are continuing to rely on imports of light sweet crude from Middle Eastern locales like Saudi Arabia, the United Arab Emirates, Iran, Qatar and Iraq. At this point, that appears unlikely to change in a significant enough way to make Alberta oil competitive.

Price discount results from lack of capacity, not location

The reality is that Alberta oil will always sell at a discount to lighter crude with greater market access.

In fact, back in 2014 a vice-president at the Canadian Association of Petroleum Producers told the Toronto Star that “there’s always a natural discount in the range of $15 to $25 [per barrel].”

In recent years, the “discount” has hovered around $10/barrel.

Nothing about a new pipeline will change the fact that Alberta’s heavy oil takes more effort to refine into usable products and is located farther from major markets than most other sources.

“It’s the lack of pipeline capacity that creates the price discount for Alberta. It’s not where that pipeline capacity goes. It’s not the difference between the U.S. Gulf and Asia,” Tom Gunton, professor and director of Simon Fraser University’s resource and environmental planning program, told DeSmog Canada.

“It’s got to do with that there’s not enough pipeline capacity.”

When Trans Mountain was pitched in 2013, there was a legitimate shortage of pipeline capacity, a reality made more concerning to industry by massive production forecasts for future decades. It seemed like an imminent and long-term backlog was about to emerge — which would actually lead to a price discount.

But then the 2014-15 price crash happened, new pipelines came online and dozens of proposed oilsands projects were either scrapped or put on hold.

When former U.S. president Barack Obama’s vetoed TransCanada’s Keystone XL pipeline in 2015 the backlog idea began gaining traction once again. But the veto has since been rescinded by President Donald Trump.

Gunton said that if you combine Keystone with Enbridge’s Line 3 and the proposed Mainline expansion, “there is more than enough pipeline capacity to meet all of Alberta’s needs without Trans Mountain” meaning that no serious price differential will emerge.

TransCanada spill in South Dakota responsible for current discount

The main reason that Alberta is currently experiencing a larger differential than usual (around $25/barrel) is because TransCanada’s Keystone pipeline spilled almost 10,000 barrels of oil into a South Dakota field in November — the third incident from the pipeline since 2010.

As Allan pointed out in a letter to the Calgary Herald, this means that around 120,000 barrels per day have been backlogged, accounting for the widening differential. You can basically see the moment when the spill happened on differential estimations, increasing from $11/barrel in November to $25/barrel in February.

It is not a lack of market access to Asia that gutted returns for oil companies — it’s a pipeline spill. The phenomena of spills squeezing pipeline capacity is something Allan has previously documented.

Gunton said that even the two reports submitted by Kinder Morgan to the National Energy Board — the first of which was striked as evidence after its author, Steven Kelly, was controversially appointed to the regulator — didn’t identify an “Asian premium.” Instead, they argued that some of the shipments out of Alberta would have to go by rail due to inadequate pipeline capacity, reducing netbacks to producers. That’s no longer true.

“That’s another big lie that there’s this big demand in Asia,” said Green Party leader Elizabeth May. “There’s this series of assumptions that are repeated so often that nobody questions them.”

Most expanded capacity will end up in California, not Asia

But while politicians like Rachel Notley continue to repeat the fiction “that there is now and will always be a pretty substantial market for bitumen in the Asia-Pacific” many analysts have identified that most oil shipped from the expanded Trans Mountain line via Vancouver (with a significant chunk already diverted in Abbotsford to Washington refineries) will end up in California in the short term.

A 2013 report from the University of Calgary’s School of Public Policy argued: “Movement of crude supplies originating in Vancouver should satisfy U.S. West Coast demand before the first barrel crosses the Pacific to Asia.”

This is mostly because California is facing declining domestic production and imports from Alaska’s North Slope. Additionally, it already has refineries in place to process heavy oil, and Albertan bitumen could directly compete with Mexican Maya, a similar quality crude.

Based on 2017 data, only 3.4 per cent of California’s foreign crude imports came from Canada. That same year, half of the state’s imported oil came from Saudi Arabia, Ecuador and Colombia — which can all produce at far lower costs than Alberta. The state’s Low Carbon Fuel Standard also rewards crude oil with lower carbon intensity, further benefiting OPEC exporters over Alberta.

“There’s no premium to go to California,” Finn said. “There’s probably a discount because it’s farther and costs more to have ships go down there.”

U.S. Gulf Coast remains most lucrative location

So where is Alberta’s slowly-but-surely increasing oil production supposed to go? Well, where it’s always gone — to the U.S. Gulf Coast, aided by TransCanada’s Keystone XL and Enbridge’s Line 3 pipelines.

In addition, both Venezuela and Mexico’s heavy oil production have also been in steady decline in recent years, providing even more potential for Alberta to fill existing refinery capacity in the Gulf.

“As we implement climate policies and as the world transitions away from fossil fuels, production in Alberta is not going to grow very much,” Gunton said.

“It’s the highest-cost producer in the world. Consequently, the demand for pipelines is down. And there is more than enough pipeline capacity to meet all of Alberta’s needs without Trans Mountain.”

Economic circumstances have shifted dramatically since 2013 when Kinder Morgan first proposed the pipeline, which raises the question: does the company want to back away from the project for reasons that stretch beyond the opposition its facing in British Columbia?

Even with both the Alberta and federal governments discuss bailing out the private project, in an investor call on Tuesday, Kinder Morgan indicated the investment may still be “untenable.”